Tag Archives: Stimulus

Is Boosting Teacher Pay a Legitimate Use of the Stimulus?

That is the question raised by a recent headline from Fairfax County:

“Fairfax Teachers Fight for Raises Funded by Stimulus”

Now I don’t know whether teachers in Fairfax are underpaid or overpaid. And there may very well be good reason to boost their salaries (or at least to boost those of the top performers). But it makes little sense to argue that a salary boost right now would serve the original purpose of the stimulus (which was intended to stimulate the economy, for those who are still paying attention). 

Let’s try to look at this the way a Keynesian would. As Brian Caplan explained a few months back, an important element in the Keynesian model is the notion of wage rigidity. Here, according to Keynesians, is how it works:

  1. Trouble begins when aggregate demand falls (usually because animal spirits have caused a sharp decrease in investment).
  2. As this happens, firms have less revenue with which to pay salaries. They might be able to maintain employment, however, if they could convince their employees to take a real wage cut. 
  3. The problem, however, is that nominal wages are “sticky.” Employees do not want to accept lower wages and even if they did, employers would rather fire some people than lower everyone’s wage and have a disgruntled workforce.

The Keynesian solution to this dilemma is to somehow boost aggregate demand to get people spending again. As Brian has more-recently pointed out, an alternative solution that is completely consistent with the Keynesian diagnosis of the problem would be to make sure that all prices—including wages—are as fluid as possible. If we could reduce nominal wage stickiness and get people to accept lower wages during a recession, then we could lower the unemployment rate.

Somehow in practice, however, Keynesian policy usually ends up increasing nominal wage stickiness and the Fairfax teacher story is a case in point.

Addendum: My colleague, Veronique de Rugy, weighs in at NRO, noting that the Administration changed the rules in February to permit stimulus funds to be used for such a purpose.

The “Things Would Have Been Worse” Excuse

The University of Chicago’s Casey Mulligan has a great post and an interesting chart over at the NYT’s Economix blog:

Here is the thrust of his argument:

  • In promoting the Stimulus, the Administration had assumed an employment multiplier such that for every 10 people hired under the Stimulus, another 6 jobs would be created. Thus, they said that if the law passed, the unemployment rate would be down to 7 percent by now.
  • The fact that the unemployment rate is still around 10 percent means one of two things: a) the stimulus didn’t work, or b) the stimulus did work and the recession was simply much worse than the Obama Administration thought.
  • This spring, the Census hired a bunch of new workers, providing a fresh opportunity to test the fiscal stimulus hypothesis. At the same time that the Census went on its hiring binge, non-Census worker employment seems not to have budged much at all.
  • Professor Mulligan then does something very clever: He takes the Administration at its word. He assumes—as they do—that for every 10 government employees hired, another 6 jobs were created. In order to reconcile this assumption with the fact that overall employment didn’t increase much at all, he concludes that the economy must have been hit (once again!) with some extraordinary countervailing contraction right at the very time that this government stimulus was taking place. What terrible luck! 

The Bottom Falls Out

Ezra Klein conjured up a fanciful reason why the stimulus spending hasn’t stimulated… anything. Matt and Eileen broke it down pretty thoroughly. Today, Mercatus Senior Research Fellow Veronique de Rugy has some visual evidence to rebut Ezra’s Keynsian dreams.

Klein is exactly wrong when he writes:

Uncertain about the future, [consumers] spend less now. The role of the government is to step up and keep the economy moving until consumer confidence returns.

Uncertainty isn’t a side-effect of a downturn, it’s a primary cause. In the recent bust, asset values were drastically skewed. If the government “keep[s] the economy moving,” confidence can’t ever return; everyone knows the old status quo was horribly flawed. Ezra, like Krugman, believes that government spending can drive an economy. Veronique’s chart neatly dispels the illusion that public spending can effectively supplement (or supplant) the private sector.

Like Taking Cyanide For A Headache

Greg Mankiw has a long article in National Affairs on the proper way to align incentives and stimulus spending:

Economists will no doubt long debate whether Cash for Clunkers passed a cost-benefit test. (Some early results, from Burton Abrams and George Parsons of the University of Delaware, suggest not.) But the fact that people responded to the incentive as they did — nearly 680,000 cars were purchased — suggests that a broader, more comprehensive program of incentives, such as an investment tax credit, might have stimulated spending even more.

Of course, not all tax cuts or credits are created equal, just as not all direct government spending is. One popular idea in recent years, for instance, has been a tax cut for businesses that make new hires. Indeed, the jobs bill signed by President Obama in March put in place a targeted payroll-tax exemption for some small businesses that hire people who have been unemployed for two months or more; several members of Congress have proposed broader tax cuts for businesses that hire new employees. The premise behind these policies is that, because unemployment is so high even as the economy begins to recover, we should create incentives for businesses to place unemployed workers into jobs.

There is a case to be made for a broad-based payroll-tax cut that might have this effect, but a narrower tax cut for new hires suffers from some major flaws. The basic problem is that we do not know how to properly define — or enforce a definition of — a “new hire.” Presumably we do not want a business to hire Peter by firing Paul and to then call Peter a new hire; this would cause a great deal of inefficient churning in the labor force (not to mention a great deal of unpleasantness for all the Pauls).

In this video from Mercatus’ Capitol Hill Campus, Dr. Bruce Yandle, Dean Emeritus at Clemson University’s College of Business and Behavioral Sciences, points out the faulty premise that stimulus spending increases demand. Instead, he shows that cash for clunkers and the recently expired first-time home-buyer credit simply shifted demand in time.

In short, for an incentive to actually stimulate an increase in demand, it would have to cost significantly more than the benefit created by increased economic activity. Mankiw himself explains that uncertainty is a recurring problem in economic planning:

The negative effects are even more challenging to trace. For example, if people observe the government issuing substantial debt (required to finance a stimulus), they may anticipate higher future taxes and therefore cut back on their current consumption. Increased government borrowing may also drive up long-term interest rates, which could make it difficult for people to borrow money and could therefore reduce spending today. Obviously, recovery.gov has no way to take account of these consequences, either.

Dr. Yandle presents the counter-point that economic uncertainty is not just an unfortunate side-effect of directed planning and incentives. Uncertainty is a prime driver of economic stagnation, both fiscally and psychologically. When economic rules and incentives change rapidly, private investors and business owners have to question their entire rational decision-making process.

Suddenly, planning a business is like building a house on quicksand. The point of stimulus spending is to offset a drop in aggregate demand, and hope that economic growth offsets the cost of the spending.

However, aggregate demand drops, as it did in 2008, because asset values become skewed. Aggregate demand needs time to reset, while consumers and producers determine the appropriate level of supply and demand under new conditions. The market seeks to correct uncertainty. By introducing new rules and incentives, stimulus spending time-shifts this realignment, but doesn’t supplement it. It adds more uncertainty to an already infuriatingly complex puzzle. That’s why such massive spending hasn’t had any noticeable effect on unemployment; it’s probable that Washington, with the best of intentions, has made hiring people more difficult for a longer period of time. It’s the same reason cash-for-clunkers was such a dismal failure, and the home-buyer credit shows the same symptoms.

Far from being a momentary side-effect of stimulus spending, uncertainty is a systemic problem with interventionist economic policy. The poison is worse than the medicine.

Top Ten Funded Stimulus Road Projects

The Business Insider has an interesting slideshow of the ten most expensive stimulus road projects to have received funding thus far, based on data assembled by ProPublica.

Of the ten, five are in California, two are in Florida, one is in New Jersey, one is in Alabama, and one is in Connecticut.

The most expensive project is the expansion of the Caldecott Tunnel on California’s State Route 24 between Alameda and Contra Costa counties. According to Caltrans, this improvement has been in the works for some time now, having received environmental approval in 2007, that is, long before the stimulus.

What makes this historically interesting is that construction on the orignal tunnel commenced in 1929 — but was taken over by the Public Works Administration and completed in 1937. So for the second time, the Caldecott Tunnel seems to have had fortunate timing when it comes to getting federal funding for an already-decided state project.

Grants, Earmarks, and the Stimulus

Yesterday President Obama unveiled more details about the stimulus.

It’s certainly big: 3,000 miles of electric transmission lines, 380 drinking water projects, 1,000 rural water and sewer system projects. A new website, recovery.gov, will enable people and experts to make sure money is spent where it is intended.

But accountability after money is committed does not stop a poor allocation of resources. The question isn’t, “Did the money hit the federal target?” It’s, “How does government choose the target?” I think this bill is going to set off a very large and much debate as we watch the money weaving its way through our states and communities: is there really much difference between an earmark, and a vetted, approved, and monitored government grant?

The Edifice Complex and the Stimulus

The Wall Street Journal had a great column over the weekend one of urban development’s many fads: stadiums, convention centers, and aquariums (casinos and waterfront promenades fall into this category).

The theory goes that weak urban economies can be reinvented into  entertainment destinations. Like most public investments of this sort, the demand is supposed (though not proven) and the effects  overstated. Stadiums don’t deliver their promised benefits. The underlying problems in these cities persists. Mayors should look to the institutional issues – the tax and regulatory environment, fighting crime, and pursuing policies to improve education – for solutions to urban decline.

The proposed stimulus may build things, but it’s unlikely to fix much.

New Paper on Stimulus and the States

Let me begin with one caveat: this blog is not going to feature excessive self-promotion. A string of press releases do not a blog make.

With that out of the way, I want to bring your attention to a new policy brief by Eileen Norcross and Frederic Sautet entitled “The Main Street Economic Recovery Proposal: Will It Bring Us Out of Recession?” Clearly, stimulus package focusing on “shovel-ready” projects will invariably be played out on the state and local level.

In the paper, Norcross and Sautet recommend:

Instead of engaging in activist fiscal policy, the government should announce a policy of fiscal prudence promoting lower public spending and thereby creating a good context for entrepreneurial activity.

1) Let the price mechanism run its course. Prices in some economic sectors have been artificially inflated for too long. Downward adjustment of prices will release resources from unprofitable sectors to more profitable ones where they are most useful.

2) Restore a climate favorable to entrepreneurial discovery and innovation. In order to discover new business opportunities, entrepreneurs must have the confidence that they can invest and be rewarded for it. But while the institutional environment must reward entrepreneurial activity, it should not socialize losses by subsidizing failure.

Fred and Eileen also wrote about the states and stimulus in November in Forbes.